AUDITING THEORY

October 1989
1.

The following statements relate to the accounting

profession :
I.
The essential difference between professional
and non professional work is the professional's
need for procedural skill.
II.
To merit public trust and confidence, the
professional person must convince the public
that he will place public service ahead of
personal reward.
III.
A CPA certificate is evidence of basic
competence in the discipline of accounting at the
time the certificate is granted.
IV.
A code of professional conduct is one of the most
important distinguishing characteristics of a
profession.
State whether the foregoing statements are true or
false.
a. All of the statements are true.
b. Only one of the statements is true.
c. Only two of the statements are true.
d. Three of the statements are true.

2.

Under generally accepted auditing standards, which of

the following reflects application of a general standard?
a. The initial planning of the audit engagement.
b. Confirmation of accounts receivable.
c. Completion of an internal control questionnaire.
d. Assignment of audit personnel to continuing
professional education programs conducted by the
firm.

3.

A CPA firm conducted a limited examination of the

financial statements of DEF Co. Because of the
incomplete scope of the audit work, the CPA firm was
unable to obtain sufficient competent evidential matter

and accordingly declined to issue an audit report.

However, at the client's request, the firm provided
financial statements on the CPA firm letterhead
stationery. The CPAs expressed no opinion. What
generally accepted auditing standard was violated?

a.
b.
c.
d.

The third standard of field work.

The third standard of reporting.
The fourth standard of reporting.
No standard was violated.

4.

The degree of risk involved has an important bearing

on the nature of the auditor's examination. From the
point of view of ''relative risk'', which of the following is
least susceptible to irregularities?
a. Cash.
b. Properly, plant, and equipment.
c. Related party transactions.
d. Accounts receivable.

5.

The following statements relate to audit evidence :

I.
To be competent, evidential matter should be
both relevant and sufficient.
II.
If strong internal control exists in a client
company, then evidence obtained internally is
much stronger than evidence obtained from
sources outside the client company.
III.
If the auditor is convinced that the underlying
accounting data is proper and accurate, it is not
necessary to obtain corroborating information.
IV.
The most reliable type of documentary audit
evidence that an auditor can obtain is physical
examination by the auditor.
State whether the foregoing statements are true or
false.
a. All of the statements are false.
b. Only one of the statements is false.
c. Only two of the statements are false.
d. Three of the statements are false.

6.

The following statements relate to audit tests and

procedures :

I.
II.

III.
IV.

Analytical review procedures are only useful at

the end of an engagement as a final overview of
the audited figures.
The purpose of obtaining management letters of
representation
is to
limit
the
auditor's
responsibility and liability for the fairness of the
financial statements.
Completeness of an asset account can be
established by vouching entries in the asset
account.
The nature, timing, and extent of the procedures
to be applied on a particular engagement are a
matter of professional judgement to be
determined by the auditor.

State whether the foregoing statements are true or

false.
a. All of the statements are true.
b. Only one of the statements is true.
c. Only two of the statements are true.
d. Three of the statements are true.
7.

The audit procedures used to verify accrued liabilities

differ from those employed for the verification of
accounts payable because
a. Accrued liabilities are incurred with the passage of
time whereas accounts payable are the result of
completed transactions.
b. Evidence
supporting
accrued
liabilities
is
nonexistent while evidence supporting accounts
payable is readily available.
c. Accrued liability amounts are less material than
accounts payable amounts.
d. Accrued liabilities at year-end will become accounts
payable during the following year.

8.

In performing an audit, which one of the following

procedures would be considered a ''substantive test''?

a. Comparing last year's interest expense with this

year's interest expense.
b. Comparing signatures on checks with the signatures
of authorized check signers.
c. Reviewing initials on receiving documents.
d. Reviewing procedures followed in receiving,
depositing, and disbursing cash.
9.

Which of the following, is most important procedure

that an auditor should use when making an overall
review of the income statements?
a. Ascertain that the net income amount in the
statement of retained earnings agrees with the net
income amount in the income statement.
b. Compare actual revenues and expenses with the
corresponding figures of the previous year and
investigate significant differences.
c. Select sales and expense items and trace amounts
to related supporting from documents.
d. Obtain from the proper client representatives,
letters of representation for the beginning and
ending inventory amounts that were used to
determined cost of sales.

10.

A CPA obtains a January 10 cut-off bank statement for

his client directly from the bank. Very few of the
outstanding checks listed on his client's December 31
bank reconciliation cleared during the cut-off period. A
probable cause for this is that the client
a. Is engaged in kiting.
b. Is engaged in lapping.
c. Transmitted the checks to the payees after yearend.
d. Has overstated its year-end bank balances.

11.

The purpose of segregating the duties of distributing

payroll checks and hiring personnel is to :
a. Separate the custody of assets from the accounting
for those assets.

b. Establish clear lines of authority and responsibility.

c. Separate duties within the accounting function.
d. Separate the authorization of transactions from the
custody of related assets.
12.

The following statements relate to the audit of cash :

I.
an improper bank reconciliation designed to
conceal a cash shortage is more likely to
overstate than to understate the amount of
outstanding checks.
II.
The bank confirmation request used by auditors
is means of obtaining documentary evidence of
both assets and liabilities.
III.
Contact with banks for the purpose of opening
company bank accounts should normally be the
responsibility of the corporate treasurer.
IV.
An auditor will request a cutoff bank statement
primarily in order to verify reconciling items on
the client's bank reconciliation.
State where the foregoing statements are true or false.
a. All the statements are true.
b. Only one statements id true.
c. Only two statements are true.
d. Three statements are true.

13.

In the audit of which of the following types of profitoriented enterprises would the auditor be most likely to
place special emphasis on testing the internal controls
over proper classification of payroll transactions?
a. A manufacturing organization.
b. A retailing organization.
c. A wholesaling organization.
d. A service organization.

14.

The following statements relate

property, plant and equipment :

to

the

audit

of

I.

15.

The auditors' objectives in examining property,

plant and equipment do not include a
determination of net realizable value.
II.
An important control procedure for plant and
equipment is the plant and equipment budget.
III.
Excessive recurring losses on assets retired may
indicate
that
depreciation
charges
are
insufficient.
IV.
Observations by the auditor of an annual
physical inventory of plant and equipment is just
essential to the issuance of an unqualified audit
report as is the observation of a physical
inventory of raw materials or merchandise.
State whether the foregoing statements are true or
false.
a. All of the statements are false.
b. Only one of the statements is false.
c. Only two of the statements are false.
d. Three of the statements are false.
The following statements relate to the audit of
inventory :
I.
An inventory turnover analysis is useful to the
auditor because it may detect the existence of
obsolete merchandise.
II.
Purchase cut-off procedures should be designed
to test whether or not all inventory purchased
before the year end was recorded.
III.
Factory overhead is normally assigned to workin-process when overhead costs are incurred.
IV.
To assure that the physical inventory is taken
properly, the auditors should prepare the
physical inventory instructions.
State whether the foregoing statements are true or
false.
a. All of the statements are true.
b. Only one of the statements is true.
c. Only two of the statements are true.
d. Three of the statements are true.

16.

In obtaining evidence to support his/her opinion, an

auditor may properly
a. Not perform substantive tests and rely solely on the
results of the study of internal accounting control.
b. Expand the scope of the audit to include a study of
administrative controls as a substitute for
substantive tests.
c. After study and evaluation, decide not to rely on
internal accounting controls and extend the
substantive tests.
d. Perform no study and evaluation of internal control
and rely solely on substantive tests.

17.

The salesmen's commission expense balance of a firm

can be efficiently substantiated by :
a. Interviewing each salesperson to determine the
amount of commission income earned during the
year.
b. Confirming by direct correspondence with each
salesperson the amount of commission income
earned.
c. Footing the total compensation paid to commission
sales staff as recorded in individual earnings
records.
d. Multiplying the contractual commission rates for
sales staff by the total amount of sales subject to
commission for the year.
Auditors may use comparison of ratios as audit
evidence. A company's current ratio is 2.2 and its quick
(acid test) ratio is 1.0 at the beginning of the year. At
the end of the year, the company has a current ratio of
2.5 and a quick ratio of .8. Which of the following could
help explain the divergence in the ratios from the
beginning to the end of the year?
a. An increase in inventory levels during the current
year.
b. An increase in credit sales in relationship to cash
sales.

18.

c. An increase in the use of trade payables during the

current year.
d. An increase in the collection rate of accounts
receivables.
19.

The following statements relate to the auditor's

working papers :
I.
A CPA who is seeking to sell an accounting
practice may allow a prospective purchaser to
look at working papers without permission from
the client.
II.
Audit working papers generally provide evidence
of compliance with the first two standards of field
work, but not the third.
III.
Working papers should never be prepared by the
client's personnel.
IV.
Working papers provide primary support for the
client's financial statements.
State whether the foregoing statements are true or
false.
a. All of the statements are false.
b. Only one of the statements is false.
c. Only two of the statements are false.
d. Three of the statements are false.

20.

The following statements relate to internal control :

I.
The
reason
for
distinguishing
between
accounting controls and administrative controls
is to identify those controls or primary interest to
the auditor.
II.
The establishment of sales terms is an example
of internal administrative control.
III.
Internal administrative control includes the
overall plan of organization and the procedures
that are concerned with the execution of
transactions in accordance with special or
general authorization.

IV.

Internal accounting controls are not designed to

provide assurance that irregularities will be
eliminated.

State whether the foregoing statements are true or

false.
a. All of the statements are true.
b. Only one of the statements is true.
c. Only two of the statements are true.
d. Three of the statements are true.
21.

When reviewing the internal controls related to the

purchase of raw materials by a manufacturing firm, the
auditor would be most concerned about :
a. Checks issued in payment for raw material
purchases that are not signed by two individuals.
b. The purchasing agent ordering raw material
primarily from a company in which the agent has a
financial interest.
c. Purchase orders which occasionally do not have the
approval of the purchasing agent.
d. Receiving reports which have pre-entered quantities
of materials expected to be received from each
vendor.

22.

The basic components of business operations and

therefore, the primary subject matter of internal control
are:
a. Functions.
b. Procedures.
c. Transactions.
d. Amortizations.

23.

The following statements relate to the independent

auditor's study and evaluation of internal control during
an examination of financial statements:
I.

Completion of an internal control questionnaire is

most closely associated with tests of compliance.

II.

III.
IV.

The primary purpose of the auditor's study and

evaluation of internal control is to provide a basis
for determining the nature, extent, and timing of
audit tests to be applied.
The study and evaluation of an internal control is
usually completed before the independent
accountant begins his audit.
The actual operation of an internal control
system may be most objectively evaluated by
completing a flowchart related tot he accounting
system in the year under audit.

State whether the foregoing statements are true or

false.
a. All of the statements are false.
b. Only one of the statements is false.
c. Only two of the statements are false.
d. Three of the statements are false.
24.

A client's materials purchasing cycle begins with

requisitions from user departments and ends with the
receipt of materials and the recognition of a liability. An
auditor's primary objective in reviewing this cycle is to:
a. Evaluate the reliability of information generated as
a result of the purchasing process.
b. Investigate the physical handling and recording of
unusual acquisitions of materials.
c. Consider the need to be on hand for the annual
physical count if this system is not functioning
properly.
d. Ascertain that materials said to be ordered,
received, and paid for are on hand.

25.

Statistical sampling techniques may be used to sample

"attributes" as well as "variables". An example of a
"variable" that can be tested using statistical sampling
technique would be:
a. The number of errors in the client-prepared aging
schedule of accounts receivable.

b. The balance in the accounts receivable account.

c. Compliance with the requirement that each voucher
be initiated by the treasurer before a check is
prepared for payment of the voucher.
d. The number of entries improperly posted to a job
order cost card.

26.

Statistical sampling is employed in auditing

a. Because it provides more assurance as to the
accuracy of records than a complete examination.
b. Because the standards of field work state that
statistical sampling should be employed to gather
evidence.
c. To draw conclusions about the entire population
based upon the qualities or characteristics of a
sample of that population.
d. To realize the auditor from having to make
judgments on sample size and items to be sampled.

27.

With respect to errors and irregularities, which of the

following would be part of an auditor's planning of the
audit engagement?
a. Plan to search for errors or irregularities that would
have a material or immaterial effect on the financial
statements.
b. Plan to discover errors or irregularities that are
either material or immaterial.
c. Plan to discover errors or irregularities that are
material.
d. Plan to search for errors or irregularities that would
have a material effect on the financial statements.

28.

Which of the following is most likely to alert an auditor

to the possibility of fraud?
a. The same person normally takes the cash items to
the bank for deposit.
b. An accounts receivable clerk took only two weeks of
a three-week vacation and was compensated for the
third week.
c. Many noncash credits to accounts receivable have
been posted.
d. The responsibility for preparing bank reconciliation
is not rotated among different employees.

29.

In connection
with the examination of financial
statements, an independent auditor could be
responsible for failure to detect a material fraud if:
a. Statistical sampling techniques were not used in the
audit engagement.
b. The auditor planned the work in a hasty and
inefficient manner.
c. Auditors performing important parts of the work
failed to discover a close relationship between the
treasurer and the cashier.
d. The fraud was perpetrated by one client employee
who circumvented the exiting internal controls.

30.

Which of the following would be considered a

significant deficiency in an audit of accounts payable?
a. Payment of an invoice three days before it was due.
b. Preparation of an accounts payable trial balance by
the accounts payable clerk.
c. Duplicate payment of a small amount.
d. Failure to record a liability for goods in transit
shipped FOB destination.

31.

C.O. Navarro, CPA is reviewing changes is sales of

Products X and Y for 1989. Sales volume (quantity)
increased 2% for X and declined 10% for Y. Sales prices
were reduced by 15% for both products. Sales in 1998
were P500,000 for X and P300,000 for Y. the auditor
expect 1989 sales for the two products to be
approximately:
a. P624,240.
b. P642,600.
c. P660,000.
d. P663,000.

32.

The following statements relate to the standard audit

report:
I.

The auditor's standard report includes both

statements of fact and opinion.

II.

The report should be signed in the name of the

auditing firm registered with the Board of
Accountancy and the SEC or in the personal
name of the auditor, if an individual practitioner.
III.
The report should be dated as of the date of
completion of the field work.
IV.
A standard audit report is in essence a
representation by the auditor that the financial
statements are presented fairly and the amounts
are accurate and correct.
State whether the foregoing statements are true or
false.
a. All of the statements are true.
b. Only one statement is true.
c. Only two statements are true.
d. Three statements are true.
33.

On July 1, 1989, Jay company's auditors discovered

several accounting errors made in prior years. The
firm's fiscal year ends on December 31. A description of
the errors follows:
The ending inventory taken in 1987 failed to include
some units that were on hand. As a result, the
inventory was undervalued by P43,000.
The ending inventory taken in 1988 included 5,000
items that were priced in error at P10.00 each
rather than the correct amount of P1.00 each.
There were accrued salaries totaling P5,000 that
should have been recorded as salary expense and
recognized as a liability at the end of 1988. This
accrual was not made due to an oversight.
Ignoring any income tax effect, the result of the above
errors is that 1988 reported income before taxes was:
a. Overstated by P93,000.
b. Overstated by P7,000.
c. Overstated by P3,000.
d. Understated by P83,000.

34.

35.

36.

If financial statements are to meet the requirements of

adequate disclosure,
a. All information pertaining to the company must be
disclosed in the financial statements or related
notes, even though some of the disclosures may be
potentially detrimental to the company or its
stockholders.
b. All information believed by the auditor to be
essential to the fair presentation of the financial
statements must be disclosed, no matter how
confidential management believes the data to be.
c. Statement footnotes must clearly detail any
deficiencies contained in the financial statements
themselves.
d. Preparation of the financial statements should be
guided by the doctrine that more information is
always better than less.
An independent auditor is allowed to omit a separate
explanatory paragraph in the short-form report when
the opinion is qualified because of:
a. A scope limitation.
b. A change in accounting principle.
c. A departure from generally accepted accounting
principles.
d. Lack of adequate disclosure.
HIJ Company does not wish to issue a statement of
changes in financial position along with its other basic
financial statements. In these circumstances, the
opinion paragraph of independent auditor's report on
HIJ's financial statement should be worded in the
following manner:
a. In our opinion, except that the omission of a
statement of changes in financial position results in
an incomplete presentation as explained in the
preceding paragraph, the aforementioned financial
statements present fairly.
b. In our opinion, because the omission of a statement
of changes in the financial position results in an

incomplete presentation as explained in the

preceding paragraph, the financial statements
referred to above do not present fairly.
c. Since the company does not wish to issue a
statement of changes in financial position resulting
in an incomplete presentation as explained in the
preceding paragraph, we do not express an opinion
on the financial statements referred above.
d. In our opinion, subject to the omission of a
statement of changes in financial position as
explained in the preceding paragraph, the financial
statements referred to above present fairly.
37.

The following statements relate to modifications of the

standard audit report:
I.

II.

III.
IV.

When an auditor is unable to reach a conclusion

as
to
the
propriety
of
management's
representations, he should consider issuing
either a qualifying opinion or a disclaimer of
opinion.
When restrictions that significantly limit the
scope of the audit are imposed by the client, the
auditor generally should issue an adverse
opinion.
Qualifying language may be added to the opinion
paragraph of the auditor's report, but it is never
added to the scope paragraph.
A change in accounting principle from one
generally accepted accounting principle to
another would not prevent the issuance of an
unqualified audit report provided the auditor
approved the change in advance and the effects
of the change were set forth in a note to the
financial statements.

State whether the foregoing statements are true or

false.
a. All of the statements are true.

b. Only one of the statements is true.

c. Only two of the statements are true.
d. Three of the statements are true.
38.

39.

The preliminary balance sheet of Pateros, Inc. prepared

on December 31, 1989 included a P3,000,000 note
payable due April 20,1990. On January 10, 1990, the
company issued additional shares of its common stock
for cash proceeds of P4,800,000 and used P2,300,000
of these proceeds to reduce the note payable. Audited
financial statements were to be released on March 15,
1990 while management was still in the process of
negotiating a line of credit that would be used to
expand operations and to eliminate the remaining
balance of the P3,000,000 note payable. In the audited
December 31, 1989 balance sheet, the required
presentation regarding the P3,000,000 note payable is
to report a:
a. P3,000,000 current liability since the debt was not
paid before December 31, 1989.
b. P3,000,000 long-term liability since current assets
will not be used to liquidate the debt.
c. P3,000,000 long-term liability since a debt was or
will be refinanced on along-term basis.
d. P700,000
current
liability
and
P2,300,000
noncurrent liability since only a portion of that debt
was refinanced on a long-term basis.
Hiyas Co. ships goods top customers FOB destination
and records the sales three days after shipment. In
reviewing the company's sales cutoff as of October 31,
1989, S.G. Vibar, CPA, noted the following items:
Invoice
Number
707
708
709
712

Selling price
Date
Month
(50% above cost)
Shipped recorded
P 7,500
6,300
9,000
4,500

Oct. 28
Oct. 29
Oct. 30
Nov. 2

October
October
October
October

715

8,100

Nov. 4

November

If Hiyas makes the required adjustments, net income

for the period ended December 31, 1989 will decrease
by:
a. P 1,500.
b. P 4.500.
c. P 6,600.
d. P13,500.
40.

If management fails to provide adequate justification

for a change from one generally accepted accounting
principle to another, the auditor should:
a. Qualify the opinion as to consistency.
b. Qualify the opinion as to noncompliance with
generally accepted accounting principles.
c. Qualify the opinion as to consistency and as to
conformity with generally accepted accounting
principles.
d. Disclose the matter in a middle explanatory
paragraph.

41.

The term "peer review" refers to:

a. The process of evaluating CPA staff members for
promotion to partnership in the firm.
b. The study and evaluation of a CPA firm's quality
control policies and procedures by another CPA firm
or a team of qualified CPAs.
c. The review of the audit working papers by the audit
partner or principal to determine whether the audit
was adequately performed and to evaluate whether
the results are consistent with the conclusions to be
presented in the auditor's report.
d. A study or appraisal by the Board of Accountancy or
its duly authorized representatives of one or more
aspects of the professional work of a firm or
partnership engaged in the practice of public
accountancy.

42.

Which of the following is not one of the functions of the

Board of Accountancy as specifically provided under
the Revised Accountancy Law ( PD 692)?
a. To determine and prescribe minimum requirements
leading to the admission of candidates to the
certified public accountant's examination.
b. To investigate violations of the Accountancy Law
and the rules and regulations promulgated
thereunder.
c. To perform visitorial powers or review professional
work of accounting practitioners on a general or
random basis.
d. After due process, to suspend, revoke, or reissue
certificates of registration for causes provided for by
law or by the rules and regulations promulgated
therefor.

43.

As promulgated under PD 1445 (The Government

Auditing Code of The Philippines) examination and
evaluation standards for government auditing include
all of the following, except:
a. A review shall be made of compliance with legal and
regulatory requirements.
b. The audit work shall be adequately planned and
assistants shall be properly supervised.
c. The auditor shall obtain through inspections,
observation inquiries, confirmation and other
techniques, sufficient competent evidential matter
to afford himself a reasonable basis for his opinions,
judgments, conclusions, and recommendations.
d. The auditor should be aware of the possibility of
illegal acts that could have an indirect and material
effect on the financial statements or results of
financial related audits.

44.

Governmental effectiveness (program) auditing seeks

to determine whether the desired results are being
achieved and objectives are being met. The first step in
the performance of such an audit would be to:
a. Evaluate the system used to measure results.
b. Determine the sampling frame to use in studying
the system.
c. Collect and analyze quantifiable data.
d. Identify the legislative intent of the program being
audited.

45.

The following statements relate to compliance with the

code of professional ethics for certified public
accountants:
I.
II.
III.
IV.

A CPA is prohibited from assisting a client in

preparing forecasts of the results of future
transactions and events.
A CPA may retain client records as a means of
enforcing payment of an overdue audit fee by
the client.
It is unethical for a CPA to undertake an
engagement if his fee is to be based upon a
percentage of audited net income.
It is unethical for a CPA to pay a commission to
an attorney to obtain a client.

State whether the foregoing statements are true or

false.
a. All of the statements are false.
b. Only one of the statements is false.
c. Only two of the statements are false.
d. Three of the statements are false.
46.

In what audit document would you expect to find the

following statements?
Our examination will be made in accordance with
generally accepted auditing standards. Accordingly, we

47.

48.

will selectively test the accounting records of the

Company and related data, and will perform other
auditing procedures by methods and to the extent we
deem appropriate.
a. An audit engagement letter.
b. A letter of representation.
c. An audit program.
d. A standard audit report.
All of the following are "auditing through the computer"
techniques except:
a. Reviewing source code.
b. Test-decking.
c. Automated tracking and mapping.
d. Integrated test facility.
Which of the following represents the greatest point of
contrast in comparing the work of the independent CPA
and the internal auditor?
a. Attention given to system of internal control.
b. Gathering of evidence.
c. Use of test and samples.
d. Emphasis on administrative controls.